If you are thinking about starting a nonprofit organization, setting it up correctly right from the start will make life easier for you and your team in the long run. First, you must determine whether your nonprofit will be a public charity or a private foundation. Both qualify as charitable organizations, but let’s dive deeper into each so you can choose the best way to proceed for your nonprofit.

What is a charitable organization?

A charitable organization is any one that meets the requirements of IRS Code section 501(c)(3) and is therefore exempt from federal income tax. Note that every exempt charitable organization is classified as either a public charity or a private foundation. Also, any contributions made to these charitable organizations are tax deductible.

What is a public charity? 

Generally, public charities are usually schools, churches, hospitals, and medical research organizations with active fundraising programs that receive contributions from multiple sources — usually from the general public, government agencies, corporations, private foundations, or other public charities. These publicly collected funds directly support the charity’s initiatives.

What is a private foundation?

A private foundation is typically created by a single benefactor — an individual or a business — through an endowment of funds. A good example is the Bill and Melinda Gates Foundation. The foundation receives most of its contributions from only a few sources. In most cases, it relies on investment earnings as the primary source of perpetual support. Also, the income generated from the foundation’s investments is dispersed as grants to individuals or other charities aligned with the foundation’s charitable causes.

What’s the main difference between a public charity and a private foundation? 

The main difference between a public charity and a private foundation is how funds are acquired. A private foundation is funded by an endowment from a single source. A public charity, however, continually solicits donations from the public — primarily organizations and individuals. A public charity’s money is used to conduct activities and initiatives related to its purpose. Private foundations, however, provide grants to other charities or individuals. Note that a public charity can receive funds from a private foundation, but a private foundation cannot receive funds from a public charity.

What are the pros and cons of a charitable organization?

Public charities usually have more significant donor tax-deductible giving limits than private foundations. Many feel that public charities are more desirable than private foundations because they appeal to public sentiment. After all, tax-deductible donations are an excellent incentive to entice donors to contribute. That’s helpful, considering that a public charity must receive one-third of all its funding from public donations. Also, the charity’s board members must be independent and represent a broad public interest. Lastly, a public charity must file a Form 990 or Form 990-EZ with the IRS.

What are the pros and cons of a private foundation? 

While establishing a private foundation requires a more significant up-front income commitment, the main benefit of a private foundation is that it has a larger degree of control. The person who runs the foundation makes the investment decisions and decides what or whom to support. In fact, the board members can entirely consist of one single family. But that freedom can also be a negative factor, as they could easily disregard public opinion and support controversial projects. With that in mind, private foundations are also subject to more restrictive operational provisions (see IRS Code sections 4940-4945). Also, private foundations require more mandatory paperwork and a minimum of 5% asset distribution each year. Lastly, all private foundations are required to file Form 990-PF with the IRS.

What’s the difference between a charity’s Form 990 (or 990-EZ) and a foundation’s 990-PF?

While a charitable organization’s Form 990 might seem daunting, a private foundation’s 990-PF is more complex and requires more calculations. What’s more, the Schedule B section of the 990-PF publicizes the names of donors to the foundation. A charity’s Form 990 and 990-EZ must also be made public. This type of accountability has its benefits, but it also has the potential to be unflattering if the nonprofit is experiencing financial or administrative challenges. To overcome that, many nonprofits hire independent third parties to audit the organization’s books and operations to ensure compliance with the tax codes and help instill industry best practices.

The bottom line

If you are contemplating starting a nonprofit, both a public charity and a private foundation are excellent options for providing charitable services. As you may have gathered, a private foundation is the best choice for those who wish to leave a legacy and who have an inheritance or a high-value estate they’d like to shield from taxes. Either way, all 501(c)(3) organizations come with finance and accounting challenges, but none that we haven’t tackled before. Our expert accounting team at Qbix can help you overcome them with ease. In fact, we can even help you prepare your Forms 990, 990-EZ, or 990-PF. Ready to experience it for yourself? Schedule a free-of-charge consultation today.

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